Federal Reserve Board invites comment on a proposal to apply netting protections to a broader range of financial institutions

The Federal Reserve Board on Friday requested comment on a proposal to reduce risk and increase efficiency in the financial system by applying netting protections to a broader range of financial institutions.

The proposal would amend Regulation EE (Financial Institution Netting) to apply netting provisions of the Federal Deposit Insurance Corporation Improvement Act of 1991 (FDICIA) to certain new entities including swap dealers. The proposal would also make minor clarifications to the existing activities-based test in Regulation EE to clarify how the activities-based test applies following a consolidation of legal entities.

Sections 401-407 of FDICIA validate netting contracts among financial institutions. Parties to a netting contract agree that they will pay or receive the net, rather than the gross, payment due under the netting contract. FDICIA provides certainty that netting contracts will be enforced, even in the event of the insolvency of one of the parties.

Regulation EE currently includes an activities-based test pursuant to which an entity can qualify as a financial institution for purposes of FDICIA’s netting provisions if it is a market intermediary and, during the previous 15-month period, it engaged in financial contracts exceeding specified numerical thresholds. Consistent with FDICIA’s goals of reducing systemic risk and increasing efficiency in the financial markets, the Board proposes to expand the definition of financial institution to ensure that certain entities qualify as financial institutions, including swap dealers and security-based swap dealers; major swap participants and major security-based swap participants; nonbank systemically important financial institutions; certain financial market utilities; foreign banks; bridge institutions; and Federal Reserve Banks.

The Board also proposes to clarify that, following a consolidation of legal entities, the surviving entity can determine whether its financial contracts exceeded the numerical thresholds in the activities-based test by considering the aggregated financial contracts of the consolidated persons during the previous 15-month period.

The Board’s notice is attached. Comments are due within 60 days of publication in the Federal Register, which is expected shortly.

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